The cost of building a Microsoft Corp.<MSFT.O> Xbox 360 video game console is nearly 40 percent higher than the retail price, technology and microchip research company iSuppli said on Wednesday.

The firm estimated the total cost to manufacture and test a premium Xbox 360, the software giant's sleek and powerful new gaming machine, which debuted on Tuesday, was $552.27, compared with its retail price of $399. Microsoft aims to sell about 5.5 million premium and lower-priced basic Xbox 360 units by the end of June. The machine will compete with the PlayStation 3 from Sony Corp. and Nintendo Co. Ltd's Revolution, each due out in 2006.

Console makers have historically subsidised manufacturing costs by creating and selling their own video games and by collecting fees from publishers who make titles for their systems. Several new Xbox 360 games are priced as high as $60.

BREAKING IT DOWN Crotty said the IBM chip that runs the Xbox 360 cost $106.

The Xbox 360's main memory from Samsung Electronics Co. Ltd added another $65, while an SIS Southbridge chip cost about $12, iSuppli said.

Other costs included a DVD drive, accessories, literature, packaging, assembly and testing.

The price of the system's two main chips should drop during the next year as manufacturing efficiency improves. That should save at least $50 per unit, in addition to other cost reductions, Crotty said.

Analysts had predicted that the Xbox 360 would initially sell at a loss.

"We expected the cost of the console to at least exceed the retail price," Crotty said.

Microsoft, currently in second place to Sony in the $10 billion U.S. video game market, is gunning for the top spot with the release of its new console.

But Crotty said the big winner in the video game wars is IBM, since its microprocessors power all three of the new consoles from the industry's heavy hitters.

The release of those machines is expected to reignite hardware sales growth. Crotty said iSuppli is forecasting 38.5 million video game consoles sold next year, up from 28.5 million in 2005.